The shape of the recovery is not given, but must be decided

Where is the UK in managing the economic impact of Covid-19? This week, Andy Haldane, chief economist of the Bank of England, gave a fascinating answer to this question: “There is a debate about which letter of the alphabet will best describe the path of the economy, with some scepticism about the V-shaped . . . path in the Bank’s May Monetary Policy Report. It is early days, but my reading of the evidence is so far, so V.”

I was among those sceptics. So let us examine what Mr Haldane is saying. He is dividing the impact of Covid-19 into four metaphorical quarters. The first is the initial impact of the virus; the second is the short-term recovery; the third consists of second-round effects on spending and employment; and the fourth is the longer-run impact.

The first quarter summary is clear: “Compared with the fourth quarter of 2019, UK [gross domestic product] fell by around 25 per cent during the first four months of this year. The fall in UK-weighted world GDP is likely to have been similarly unprecedented.” These will be the sharpest four-month GPD falls on record, in the UK and globally.

So now we are in the second quarter: the recovery. Short-term indicators suggest the recovery in both the UK and global economies came sooner and has been far faster even than in the BoE’s May scenario — “indeed, sooner and faster than any other mainstream macroeconomic forecaster”.

The BoE’s modelling suggests that world output may have been 15 percentage points lower in the second quarter than at the turn of the year, against the 26 per cent fall forecast in the May MPR. Similarly, UK GDP may have been down “only” 20 per cent in the second quarter, 7 percentage points less than in the May scenario.

So what happens over the balance of this year, in “the third quarter”?

An optimistic view would be that there remains substantial pent-up demand. So there might be an overshoot in spending. If this makes companies more confident, they may employ more people than might be expected. This would make the currently furloughed and unemployed more optimistic, creating a positive feedback on spending and the economy.

A pessimistic view would be that a significant proportion of the population, especially older people, is not going to spend as normal. This will make businesses more cautious about expanding. With such negative feedback, the recovery’s upward leg gets bent, before it even returns to its starting point.

Neither the immediate future nor what happens in 2021 and thereafter, in Mr Haldane’s “fourth quarter”, are givens.

The first priority in a recovery must be to avoid a resurgence of the disease. Another generalised lockdown would be a disaster. Yet even significant local lockdowns might be very damaging to confidence.

The second priority must be to avoid letting hopes of a strong recovery turn attention from the downside risks. The chancellor, Rishi Sunak, must not let premature fiscal retrenchment weaken the recovery. On the contrary, he should convert his package of measures, especially the furlough scheme, into programmes for promoting employment.

The final priority must be to move from recovery into a long-term expansion, as prime minister Boris Johnson said this week. Using the unique opportunity of negative long-term real interest rates to expand investment is right. The question is, rather, whether this programme and subsequent announcements by Mr Sunak and other ministers will amount to a workable programme for widely-shared prosperity.

Should any serious risk of inflation emerge, which is possible, given the scale of the monetary expansion, the Bank of England will have to act. That is its job. But, given current negative long-term real interest rates, the government can afford to borrow on an enormous scale and has to do so. There must be no repeats of the economy-sapping austerity of a decade ago

Brexit will make economic success far more difficult. But there are also opportunities to build on. The remarkably swift shift to working online is not only a huge potential boost to productivity, but also to working at a distance, though some of those opportunities will go to people working abroad.

The first stage of the Covid-19 depression is over. The speed of the recovery has surprised, so far. But many uncertainties lie ahead. Do not allow a “no deal” Brexit; do not retrench too soon; do invest in the future; and do take advantage of new opportunities. These must now be the guiding ideas.

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